Mortgage interest rate explained

The mortgage interest rate explained

When you pay back your mortgage loan you pay it back with a rate of interest added, usually paid each month. This interest rate is decided by the lender although it can change over time depending on what type of mortgage you take out.

How does the mortgage interest rate work?

How this mortgage interest rate is calculated can be quite complicated. It’s not just about the headline rate and how much you pay back but it’s also dependent on how your loan is structured overall.

To understand the mortgage rate, you can break down the mortgage into the full loan amount you’re borrowing and interest. The loan amount is how much you’re given for the mortgage and the mortgage interest rate is what the lender charges on top of that loan amount. So, with a 25-year mortgage, you pay back the loan amount plus the added interest over that time period.

An alternative is the interest-only mortgage. As it suggests, you only pay back the interest on the loan amount but not the loan amount itself. Only when the fixed mortgage term comes to an end, is the loan amount to be paid back to the lender. Lenders don’t particularly like this type of mortgage since there is more risk that the mortgage won’t be paid back by the homeowner.

Different lenders have different ways of calculating interest. It could be calculated monthly, annually or another way. For borrowers, the most favourable time period calculation is daily. Over the course of a 25-year mortgage, this can considerably lessen the amount of interest payments made.

When looking to reduce the interest you pay on your mortgage, you need to begin by looking around for the best deal possible. To help you with this, it can be worthwhile talking to an independent financial advisor or mortgage broker. The mortgage interest rate isn’t the only factor that matters in getting the best mortgage deal, even if it’s still very important.

You could also reduce your mortgage term and although this means you pay more in monthly repayments, it will reduce your long-term interest payments. Although many lenders have early repayments fees, some lenders may allow you to pay more than necessary in order to pay off your mortgage quicker and, as such, accrue less interest.

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